CHARTERED ACCOUNTANTS EXAMINATIONS

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LICENTIATE LEVEL
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L2: MANAGEMENT ACCOUNTING
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SERIES: JUNE 2013
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TOTAL MARKS – 100 TIME ALLOWED: THREE (3) HOURS
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INSTRUCTIONS TO CANDIDATES

1. You have fifteen (15) minutes reading time. Use it to study the examination paper
carefully so that you understand what to do in each question. You will be told when
to start writing.

2. This paper is divided into TWO sections:

Section A: Two (2) Compulsory Questions.

Section B: Three (3) Optional Questions. Attempt any Two (2) questions.

3. Enter your student number and your National Registration Card number on the front
of the answer booklet. Your name must NOT appear anywhere on your answer
booklet.

4. Do NOT write in pencil (except for graphs and diagrams).

5. The marks shown against the requirement(s) for each question should be taken as
an indication of the expected length and depth of the answer.

6. All workings must be done in the answer booklet.

7. Present legible and tidy work.

8. Graph paper (if required) is provided at the end of the answer booklet.
SECTION A:

BOTH questions in this section are compulsory, 30 marks each.

QUESTION ONE

Nampa Zambia Ltd produces packaging materials for various companies involved in
production. The company uses a standard absorption costing system. The standard cost
card for one of Nampak Zambia ltd’s packaging material is as follows:

K’000
Materials 3 kg 12
Labour 3.2 hours 16
Overheads:
Variable 3.2 hours 8
Fixed 3.2 hours 24
Total cost 60
Selling price 70
Production and sales information for June, 2012:
Budget Actual
Production 5,000 units 6,000 units
Sales 5,000 units 4,300 units
Sales revenue K350, 000, 000 K329, 600, 000
The resources used and actual costs for June, 2012 were as follows:
K’000
Materials 20,600 kg 77,440
Labour 22,840 hours 142,400
Overheads:
Variable 59,300
Fixed 167,600

The 22,840 labour hours include 4,540 hours of idle time. This was caused by an
unexpected machine breakdown. All of the materials purchased were used during the
month.

Required:
(i) Calculate the budgeted profit/loss for June, 2012. (2 mark)
(ii) Calculate the actual profit/loss for June, 2012. (4 marks)

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(iii) Calculate the following variances and prepare a statement that reconciles the
budgeted and actual profit/loss for June 2012.
 Materials variances (price and usage)
 Labour variances (rate, efficiency and idle time)
 Variable overhead variances (expenditure and efficiency)
 Fixed overhead variances (expenditure, capacity and efficiency)
 Sales variances ( price and volume) (16 marks)

(iv) Calculate the actual profit/loss that would be reported by Nampa Zambia Ltd if it
used marginal costing. (3 marks)

(v) Explain with relevant calculations how the reconciliation statement that you prepared
would have been different if Nampa Zambia Ltd used standard marginal costing
instead of standard absorption costing. (5 marks)

(Total: 30 marks)

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QUESTION TWO

(a) Decee (Z) Ltd has recently been acquired by Jani (Z) Ltd a much larger company. For
quite some time now (years) the budgets of Decee (Z) Ltd have been prepared
based on the current year’s results plus an extra amount for estimated growth or
inflation. The new owners (Jani Zambia Ltd) are insisting on a “zero-base” approach
when the next budget is prepared.
(i) Explain the main features of incremental budgeting and outline the problems
that can occur when using it. (5 marks)
(ii) Explain the main features of zero-based budgeting and outline the problems
that can occur when using it. (5 marks)
(iii) Explain how the use of zero-based budgeting can motivate employees.
(4 marks)
(iv) Explain TWO behavioural consequences that may result after the introduction
of participative budgeting system. (4 marks)

(b) Printo, a printing company, uses traditional absorption costing to report its monthly
profits.

It is seeking to increase its business by winning work from new customers. It has the
opportunity to prepare a quotation for a large organization that currently requires a
new catalogue of its services.

A technical report on the resource requirements for the catalogues has been
completed at a cost of K20, 000, 000 and its details are summarized below:

Material

20,000 sheets of special printing paper will be required. This is a paper that is in
regular use by Printo and the company has 6,800 sheets in inventory. The original
cost was K2,800 per sheet but the current market price is K3, 000 per sheet. The
resale price of the sheets held in inventory is K2, 400 per sheet.

Labour

Sufficient people are already employed by Printo to print the catalogue, but some of
the printing will require overtime working due to the non-availability of a particular
machine that is used on other work. The employees are normally paid K16, 000 per
hour, the order will require 300 hours of work and 100 of these hours will be in
excess of the employee’s normal working week. A rate of K20, 000 per hour is paid
for these overtime hours. Employees are paid using an hourly rate with a guaranteed
minimum wage for their normal working week.

Machinery

Two different types of machines will be required:

Machine A will print the catalogues. This is expected to take 40 hours of machine
time. The running cost of machine A is K10, 000 per hour. There is currently 60
hours of unused time on machine A per week that is being sold to other printers for
K24, 000 per hour.

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Machine B will be used to cut and bind the catalogues. This machine is being used to
full capacity in the normal working week and this is why there is a need to work
overtime. The catalogue will require 50 machine hours and these have a running cost
of K8, 000 per hour.

Dispatch

There will be a delivery cost of K800, 000 to transport the catalogues to the
customer.

Profit mark-up

Printo applies a 30% mark-up to its costs to determine its selling prices.

Required:

In order to assist the management of Printo in preparing its quotation, prepare a

schedule showing the relevant costs for the production of the catalogues. State
clearly your reason for including or excluding each value that has been provided in
the above scenario. (12 marks)
(Total: 30 marks)

(Grand Total: 60 marks)

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SECTION B:

Answer any two (2) out of three questions, 20 marks each.

QUESTION THREE

The Brotherhood Company has produced the following information from which a cash
budget for the first six months of the year is required.

The company makes a single product which sells for K50, 000 and the variable cost of each
unit is as follows:

Material K26, 000

Labour (wages) K8, 000
Variable overhead K2, 000

Fixed overheads (excluding depreciation) are budgeted at K5, 500, 000 per month payable
on the 23rd of each month.

Notes

(a) Sales units for the last two months of the year.
November December
1,000 1,200
(b) Budgeted sales units for next year.

January February March April May June

1,400 1,600 1,800 2,000 2,200 2,600

(c) Production quantities for the last two months of the year.
November December
1,200 1,400
(d) Budgeted production units for next year.
January February March April May June
1,600 2,000 2,400 2,600 2,400 2,200

(e) Wages are paid in the month when output is produced.

(f) Variable overhead is paid 50% in the month when the cost is incurred and 50% the
following month.
(g) Suppliers of materials are paid two months after the material is used in production.
(h) Customers are expected to pay at the end of the second month following sale.
(i) A new machine is scheduled for January costing K34, 000, 000; this is to be paid for
in February.
(j) An old machine is to be sold for cash in January for K1, 200, 000.

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(k) The company expects to have a cash balance of K35, 500, 000 on 1 January.
Required:
(a) Prepare a month by month cash budget for the first six months of next year.
(15 marks)

(b) Comment on the action management might take in the light of the cash
budget you have prepared. (3 marks)

(c) Explain how depreciation would affect the following:

(i) A cash budget (1 mark)
(ii) The calculation of profit in a business (1 mark)
(Total: 20 marks)

QUESTION FOUR

(a) Dom investment produces two detergents, Boom paste and Boom powder, which
pass through two production processes, X and Y. The time taken to make each
detergent in each process is:

Boom paste Boom powder

Process X 5 minutes 7.5 minutes
Process Y 18 minutes 12 minutes

The company operates a 15-hour day and the processes have an average downtime
each day of:
Process X 1.5 hours
Process Y 1.0 hours
The costs and revenues for each unit of each detergent are:
Boom paste Boom powder
K’000 K’000
Direct materials 20 20
Direct labour 18 14
Variable overhead 4 4
Fixed costs 5 4
Total cost 48 42
Selling price 95 85
Sales demand restricts the output of Boom paste and Boom powder to 50 and 80
units a day respectively.
Required:
Calculate the daily production plan that would maximize the throughput contribution
(9 marks)

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(b) Form king (Z) Ltd manufactures and sells a range of mattresses. Due to the
standardization of its products, Form king (Z) Ltd uses a standard costing system to
monitor its performance. Monthly variance reports are discussed at each monthly
board meeting.

A few months ago the Production Director attended a meeting on modern

management accounting techniques and was interested in a presentation of Kaizen
Costing. The presenter illustrated how the use of Kaizen Costing had enabled his
company to reduce its unit manufacturing costs by 15%.

Required:

(i) Explain the principles of Kaizen Costing (5 marks)

(ii) Discuss how Kaizen Costing conflicts with Form king (Z) Ltd’s current
performance reporting procedures. (6 marks)
(Total: 20 marks)
QUESTION FIVE

(a) Zinc (Z) Ltd is a manufacturing company operating in Lusaka. The summary of its
budgeted profit statement for the forth coming year is given below. The company is
currently operating at 80% of capacity.
K’000 K’000
Sales 8,000 units at K40, 000 320,000
Less: Direct materials 40,000
Direct wages 62,000
Production overhead:
Fixed 75,000
Variable 18,000
195,000
Gross profit 125,000
Less: administration, selling and distribution costs:
Fixed 39,000
Varying with sales volume 48,000 87,000
Net profit 38,000

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Required:
(i) Calculate the breakeven point in units and in value (3 marks)
(ii) Draw a contribution-volume (profit-volume) graph (3 marks)
(iii) Calculate the profit that could be expected if the company operated at full capacity.
(3 marks)

(b) Following the splendid performance and crowning of the mighty Zambian National
Soccer Team in the just ended Confederations of African Football (CAF)
Championship co hosted by Equatorial Guinea and Gabon, Beck Fashions has
designed a new and unique classic outfit for the soccer fans across Zambia. The
proprietor of Beck Fashions is inexperienced in the business world and has come to
you for advice.

Required:

(i) Advise Beck Fashions on the choice of two (2) appropriate pricing strategies for
the new and unique classic outfit. (6 marks)

(ii) Explain the difference between elastic and inelastic demand giving examples to
illustrate your answer. (5 marks)

(Total: 20 marks)

END OF PAPER

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 L2

MANAGEMENT ACCOUNTING

SUGGESTED SOLUTIONS

JUNE 20-13

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L2 SECTION A
SOLUTION ONE (NAMPA ZAMBIA LTD)
(a) Budgeted profit
Budgeted profit per unit K10, 000
Budgeted production and sales 5,000 units
Budgeted profit K50, 000,000 2 marks

(b) Actual profit/loss

K’000 K’000
Sales 329,600 ½ mark
Total costs incurred 446,740 2 marks
Closing stock:
1,700 X K60 102,000 1 mark
Cost of sales 344,740
Actual loss 15,140 ½ mark
4 marks

(c) Operating statement K’000 K’000

Budgeted profit 50,000 ¼ mark

Sales price variance 28,600 (F) ¼ mark
Sales volume variance 7,000 (A) ¼ mark
21,600 (F)
Profit before cost variances 71,600

Cost variances Adverse Favourable

K’000 K’000 K’000
Material price 4,960 ¼ mark
Material usage 10,400 ¼ mark
Labour rate 28,200 ¼ mark
Labour efficiency 4,500 ¼ mark
Labour idle time 22,700 ¼ mark
Variable overhead expenditure 13,550 ¼ mark
Variable overhead efficiency 2,250 ¼ mark
Fixed overhead expenditure 47,600 ¼ mark
Fixed overhead capacity 17,250 ¼ mark
Fixed overhead efficiency 6,750 ¼ mark
Totals 122,450 35,710 86,740 (A)
Actual loss (15,140) ¼ mark
4 marks

WORKINGS:

K’000
1. Material price variance
(K77, 440 - (20,600 x K4)) = 4, 960 (F) 1 mark
2. Material usage variance
(20,600 - (6,000 x 3)) x K4 = 10, 400 (A) 1 mark

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 3. Labour rate variance
(K142, 400 - (22,840 x K5)) = 28, 200 (A) 1 mark
4. Labour efficiency variance
((22,840 – 4,540) - (6,000 x 3.2)) x K5 = 4, 500 (F) 1 mark
5. Labour idle time variance
(4,540 x K5) = 22, 700 (A) 1 mark
6. Variable overhead expenditure variance
(K59, 300 - ((22,840 – 4,540) x K2.5) = 13, 550 (A) 1 mark
7. Variable overhead efficiency variance
((22,840 – 4,540) - (6,000 x 3.2)) x K2.5 = 2, 250 (F) 1 mark
8. Fixed overhead expenditure variance
(K167, 600 - (5,000 x K24)) = 47, 600 (A) 1 mark
9. Fixed overhead capacity variance
((22,840 – 4,540) - (5,000 x 3.2)) x K7.5 = 17, 250 (F) 1 mark
10. Fixed overhead efficiency variance
((22,840 – 4,540) - (6,000 x 3.2)) x K7.5 = 6, 750 (F) 1 mark
11. Sales price variance
(K329, 600 – (4,300 x K70)) = 28, 600 (F) 1 mark
12. Sales volume variance
((5000 – 4300) x K10) = 7, 000 (A) 1 mark
12 marks

16 marks

(d) The actual loss would be greater under marginal costing due to the non absorption
of fixed overhead costs into the unsold stock items.
The loss would increase by 1,700 units x K24, 000 = K40, 800, 000 so that under marginal
costing the loss would be K55, 940, 000. (Max = 3 marks)

(e) There would be no change to the budgeted profit as there was no budgeted change
in the level of stocks.

The sales volume variance would be valued on a contribution basis so that it increases to
K23, 800, 000 Adverse (700 units x K34, 000), an increase of K16, 800 adverse.

The fixed overhead capacity and efficiency variances would not exist, thus removing

favourable cost variances totalling K24, 000, 000.

There would be no other changes and so, by totalling the above, it can be seen that they
equate to K40, 800,000 adverse, which equals the increase in the size of the loss as per part
(d) above. (Max = 5 marks)

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SOLUTION TWO

(a) (i) The main features of incremental budgeting

Incremental budgets use the budget from the last period and add a given % to the figures.

This method is very quick and easy to use and is therefore a cheap way to prepare budgets.

Problems which can occur

 Incremental budgeting assumes that nothing has changed, other than

perhaps the sales figure or a few price changes. This is unrealistic. It
is likely that there are parts of the operations that have
ceased/started/changed over the last year. These changes must be
incorporated to make the budget relevant.
 If the current budget has any inefficiencies in it, for example waste
from the manufacturing process, the new budget will simply accept
this and build it into the budget. This is inappropriate as the company
should be aiming to cut those costs.
 If a company uses the budget to set targets for its employees it is
likely that the figures are either very easy or very hard to achieve as
they will not have been appraised for reasonableness year to year.
 With incremental budgeting it is easier for managers to build slack
into their figures as they do not have to justify each individual figure.

((Features = 2 marks, Problems = 3 marks) Max: 5 marks))

(ii) The main features of zero-based budgeting

The budget will be started from scratch or a “zero-base each period. Every figure included in
the budget will have to be justified and approved.

As so much detail is included in the zero-based budget it is very time consuming and
therefore expensive.

Problems which can occur

 As it is very detailed it is unlikely that staff will have the correct level
of expertise and so training will need to be given to staff, costing
more time and money.
 The process will also mean that management will need to commit
more time to the budgeting process.
 Often the systems used by companies are not capable of producing
the detailed information required by this approach. It is possible that
new systems will have to be installed/developed, again at a cost to
the company.

((Features = 2 marks, Problems = 3 marks) Max: 5 marks))

(iii) How zero-based budgeting can motivate employees

 Receiving training and investing in developing employees can motivate
individuals

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  No slack will be built in and so targets will be realistic. This should help
motivate individuals.
 Zero-based budgeting will require a lot of input from the employees.
Being involved in providing information and helping to make decision can
help motivate individuals.
 Individuals will no longer be able to get away with building inefficiencies
into their budget. This should remove any animosity between
departments/budget holders who considered others to be acting unfairly.
A more equitable environment should help motivate individuals.

(1 mark each, max: 4 marks)

(iv) Behavioural consequences that may result after the introduction of

participative budgeting
 Participative budgeting will mean that more individuals are involved in the
budgeting process. They should therefore feel more ownership of the
budget and hence feel more committed towards achieving it.
 If individuals are more involved in setting the budget figures, it is possible
that they will build slack into their figures to make any targets set easier
to achieve. This may mean that the company will lose money as they will
not be operating to make the most sales/keep costs as low as they could
do due to the amended figures.
 The introduction of participative budgeting will be a change to the
employees. People tend to not like change and may not co-operate
initially. This can lead to frustration and demotivation.
(Any two points, 2 marks each. Max: 4 marks)
(b) Relevant costs K’000
Material 60,000 20,000 sheets at K3, 000 / sheet.
Material is in regular use so must be costed at market price

Direct labour 2,000 100 hours @ K20, 000/hr.

Overtime only as 200 hours idle time already paid for
unguaranteed minimum wage.

Machine A 960 40 hours @ K24, 000/hr.

Opportunity cost of lost income.

Machine B 400 50 hrs @ K8, 000/hr.

Cost of overtime as machine fully utilized in normal hours.
Despatch 800 Additional cost which will be incurred due to this contract.

Total 64,160
relevant
Not relevant

Technical 0 This is a sunk cost

report
Profit mark-up 0 Profit mark-up is not a relevant cost of the project.

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Marks Allocation
Materials 2 marks
Labour 2 marks
Machine A 2 marks
Machine B 2 marks
Despatch 1 mark
Total relevant 1 mark
Technical report 1 mark
Profit mark-up 1 mark
12 marks

SECTION B

SOLUTION THREE

(a) Initial workings

(i) Sales value
Nov Dec Jan Feb Mar Apri
Sales units 1,000 1,200 1,400 1,600 1,800 2,000

K’000 K’000 K’000 K’000 K’000 K’000

Sales value at K50, 000 50,000, 60,000 70,000 80,000 90,000 100,000
Sales revenue will be received two months after the sale is made.
(ii) Production costs
Nov Dec Jan Feb Mar Apr May Jun
Production units 1,200 1,400 1,600 2,000 2,400 2,600 2,400 2,200
K’000 K’000 K’000 K’000 K’000 K’000 K’000 K’000
Wage at K8,000 12,800 16,000 19,200 20,800 19,200 17,600
Variable o/h at K2, 2,400 2,800 3,200 4,000 4,800 5,200 4,800 4,400
50% paid in month 1,200 1,400 1,600 2,000 2,400 2,600 2,400 2,200
50% following 1,200 1,400 1,600 2,000 2,400 2,600 2,400
month
Total payment 3,000 3,600 4,400 5,000 5,000 4,600
Material at K26, 000 31,200 36,40 41,600 52,000 62,400 67,600 62,400 57,200
Payments after two 31,200 36,400 41,600 52,000 62,400 67,600
months

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CASH BUDGET FOR FIRST SIX MONTHS OF NEXT YEAR
JAN FEB MAR APR MAY JUNE
K’000 K’000 K’000 K’000 K’000 K’000
Receipts
Sales revenue 50,000 60,000 70,000 80,000 90,000 100,000
Sale of old machine 1,200 - - - - -
51,200 60,000 70,000 80,000 90,000 100,000
Payments
wages 12,800 16,000 19,200 20,800 19,200 17,600
Variable overhead 3,000 3,600 4,400 5,000 5,000 4,600
Material 31,200 36,400 41,600 52,000 62,400 67,600
Fixed overhead 5,500 5,500 5,500 5,500 5,500 5,500
New machine - 34,000 - - - -
52,500 95,500 70,700 83,300 92,100 95,300
Net cash flow (1,300) (35,500) (700) (3,300) (2,100) 4,700
Opening cash balance 35,500 34,200 (1,300) (2,000) (5,300) (7,400)
Closing cash balance 34,200 (1,300) (2,000) (5,300) (7,400) (2,700)
Marks Allocation
(Workings) – 5 marks
 Sales value 1 mark
 Wages 1 mark
 Variable overheads 2 marks
 Payments for materials 1 mark
Actual cash budget – each line 1 mark (Max: 10 marks)

(b) The cash budget shows that the company will require more cash than is available
from February onwards. Management might decide to arrange an overdraft to cover
the deficit. Alternatively, they could reduce or avoid the deficit by taking actions such
as the following.

(i) Negotiate credit facilities or stage payments for the purchase of the machine.
(ii) Defer the purchase of the machine or lease it instead of buying
(iii) Defer payments of material suppliers, although the company already takes
two months credit for these purchases.
(iv) Attempt to collect payments from customers more quickly.
((Any three points, 1 marks each (Max: 3 marks))

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(c) (i) Depreciation is not a cash flow and so would have no effect on a cash budget.
1 mark
(ii)
Depreciati
on is charged in the income statement for the year and therefore reduces the profit of a
business. 1 mark

SOLUTION FOUR

(a)
Production time Process X: 15 – 1.5 =
13.5 hrs ½ mark
Production time Process X: 15 – 1 =
14 hrs ½ mark
Throughput of process X per day = Boom paste
( ) 1
mark
= Boom powder (

1 mark

Throughput of process Y per day = Boom paste

1 mark
= Boom powder ( ) 1
mark
Process Y limits the production of both detergents to figures that are less than sales
demand.
Boom paste Boom powder
K’000 K’000
Selling price 95 85
Direct materials 20 20
Contribution per unit 75 65 1 mark
Time taken per unit 18/60 0.2
Throughput contri per limiting K250 K325 1 mark
factor
Rank 2 1 1 mark

Processing 70 units of Boom powder will give the larger throughput contri/ per day.
1 mark

1. (i) Continuous improvement, or ‘Kaizen’, is an integral part of the just-in-time

management philosophy. ‘Kaizen’ is a Japanese term meaning to improve
processes via small, incremental amounts rather than through large
innovations. Kaizen costing is a planning method used during the
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 manufacturing cycle that emphasises reducing variable costs of a period
below the cost level in the base period. The target reduction rate is the
ratio of the target reduction amount to the cost base.

 The organization should always seek perfection. Perfection is never

achieved, so there must always be some scope for improving on
current methods and procedures. Improvements should be sought all
the time.
 Improvements will be small and numerous rather than occasional and
far-reaching.
 Cost reduction targets are set and applied on a more frequent basis
than standard costs. Typically these targets are set on a monthly basis
whereas standards within a traditional standard costing system are set
annually or perhaps semi-annually.

In the Kaizen system, the employees often work in teams and are empowered to make
changes to production that would have to be cleared through a management hierarchy in a
more static standard costing system.
Marking guide
1 mark per point. Points include:
 Continuous review of systems and procedures
 Small incremental cost savings
 Used in the production phase
 Employee empowerment
(ii)

Standard Costing Concepts Kaizen Costing Concepts

Cost control system concepts. Cost reduction system concepts.
Assume current manufacturing conditions. Assume continuous improvement in
manufacturing.
Meet cost performance standards. Achieve cost reduction targets.

Standard Cost Techniques Kaizen Costing Techniques

Standards are set annually or semi-annually
Cost variance analysis involving standard
costs and actual costs
Investigate and respond when standards are
not met.
Marking guide:
Cost reduction targets are set and applied
monthly
Continuous improvement (Kaizen) is
implemented during the year to attain target
profits or to reduce the gap between target
profits and estimated profit.
Cost variance analysis involving target Kaizen
costs and actual costs reduction amounts.
Investigate and respond when target Kaizen
amounts are not attained.

1 mark per point. Points could include:

 Standard costing & variance analysis are used to measure performance

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  Standards are set at the start of the year as targets for the year
 Annual targets do not allow for improvements
 Kaizen costing encourages improvements
 Kaizen costing uses a moving target
 A moving target conflicts with having a static target
 Managers may be confused by moving targets
 Trend analysis is difficult with a moving target
QUESTION FIVE

(a) (i)
K’000 K’000
Sales 320,000
Variable costs: Direct 40,000
materials
Direct labour 62,000
Production overhead 18,000
Variable admin costs etc 48,000
168,000
Contribution 152,000

Contribution per unit = K152, 000,000/8,000 = K19, 000

Breakeven point (UNITS) = fixed costs/contribution per unit

= (K75, 000,000 + K39, 000,000) / K19, 000
= 6,000 units
Breakeven point (sales value) = 6,000 units x K40, 000 = K240, 000, 000

(3 marks)

(ii)

Profit

Profit

Loss 6,000 Volume of units

Loss

K76 million (3 marks)

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Assuming that cost behaviour patterns remain the same if activity increases to 100%, a
profit of K76, 000, 000 can be expected.

K’000
Contribution (10,000 x K19, 000) 190,000
Less: fixed production overhead 75,000
Fixed administration costs etc 39,000
Profit 76,000
(3 marks)

(b) (i) Beck Fashions can choose from an assortment of different pricing strategies.
Detailed below are the three most suitable strategies:

 Cost plus pricing

Beck Fashions will need to ascertain the cost for producing one outfit. This can be
complicated and help can be given to find the cost.

Beck Fashions would take that cost and add a percentage to it which will represent the profit
on that item and give the selling price. Which cost to take can be a difficult decision. The
company could use marginal cost (just taking into account the variable costs of production)
or absorption cost (taking into account all costs of production).As Beck Fashions is trying to
decide the selling price for the long term, absorption costing is likely to be more appropriate
as there is a risk of not covering fixed costs when using marginal costing. The company will
also have to decide whether to use standard cost (the expected cost) or actual cost for this
process. It is often a good idea to use the standard cost to give an incentive to the
workforce to keep costs low. Beck Fashions will also be able to use the standard cost to
assess their performance against budget.

 Price skimming
A new and classic outfit is the first of its type to market. It could therefore sell each unit at a
high price compared to the rest of the outfits on the market at this time. Those people that
love to have the outfits will be willing to spend more on this item and profit per unit will be
high. The company can then bring down the price as time passes and increase the number
of sales, even at a lower price.

Beck Fashions will have to spend money on marketing, especially PR, to make this product
desirable at its higher price.

 Penetration Pricing
Beck Fashions could do the opposite and sell it’s product at a cut price to gain market Share.
The Company should sell an increased number of outfits, albeit at a lower price. The
company could then increase the price at a later date.

(Any two, 3 marks each. Max: 6 marks)

(ii) The price elasticity of demand (PED) measures the change in demand in
response to a change in price. It can be calculated using the following equation:

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 Change in quantity demaned as a % of demand
= (1 mark)
Change in price as a % of price

Elastic demand has a PED of greater than 1.This means that if the price changes by say
10% the demand will change by a percentage higher than this, say 15%. In other words,
elastic products are price sensitive. An example of an elastic product is a holiday. (2
marks, 1 – elastic, 1 – example)

Inelastic demand has a PED of less than one. This means that when the price changes by
say 10% the demand will change by a percentage lower than this, say 5%.These products
will still be bought even when the price goes up. An example of an inelastic product is a
pack of cigarettes. (2 marks, 1 – inelastic, 1 – example)

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